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Will Big Banks Get Ambushed by Congress?

A new bill has "too big to fail" in its sights

After treading water yesterday, U.S. stocks have resumed the week's rally this morning, with the S&P 500(SNPINDEX:^GSPC) and the narrower, price-weighted Dow Jones Industrial Average(DJINDICES:^DJI) up .5% and .3%, respectively, at 10:15 a.m. EDT.

Targeting "too big to fail"As the details of a new bill that has megabanks in its crosshairs emerges, lawmakers have already exceeded my expectations regarding how far they are willing to go to tackle the problem of too-big-to-fail banks. Unfortunately, that's largely a reflection of how low my expectations were, as the banking lobby wields excessive influence on Capital Hill. Still, the new bill is cause for hope.

Last month, I highlighted the fact that the U.S. Attorney General's admission that financial stability concerns acted as a deterrent to prosecuting megabanks had provided a fresh impetus on the Hill to tackle "too big to fail." Now, Sherrod Brown (D-OH) and David Vitter (R-LA) are sponsoring a bill that would require institutions with over $500 billion in total assets to hold capital equal to at least 15% of their assets. Dow components Bank of America(NYSE:BAC) and JPMorgan Chase(NYSE:JPM), as well as Citigroup(NYSE:C), fall in the category.

That ratio is much higher than the 9.5% that the international Basel III framework calls for, for the largest, most interconnected global institutions. This is particularly so, as the bill's minimum ratio is based on the total assets figure at the bottom of the bank's balance sheet, rather than risk-weighted assets, which rely on a bewildering set of risk assumptions that give banks considerable leeway in coming up with a figure.

While JPMorgan's CEO once complained that the Basel capital requirements were "anti-American," here we have a home-grown alternative that is much stricter! In fact, a 15% minimum ratio would be quite sensible, as I've argued in the past. If it were enacted, megabanks' returns on equity would drop, yes, but they would be much safer, and it would discourage smaller banks from pursuing size solely to achieve TBTF status and the implicit funding subsidy that goes along with it.

Does the new bill have a realistic chance of passing? I don't think so. If it were to pass, bankers will have seriously underestimated lawmakers' resolve on this issue. Certainly, investors don't appear to give it much chance -- shares of Bank of America and JPMorgan Chase were both up roughly 1% at 9:52 a.m. EDT.